Boiler Rooms And Silver Manias

It’s not safe out there, folks.

There was quite a bit of chatter last week about the “hunters becoming the hunted,” where that meant the Reddit crowd was on the prowl and hedge funds were the prey.

“A new warrior class of retail investor [is] roaming the equity savannah,” SocGen’s Albert Edwards wrote, calling the Reddit traders a “loosely organized retail mob” which is “gaining strength feasting off each hedge fund kill.”

They dealt a grievous blow to Melvin Capital, that’s for sure. The firm was down 53% last month.

But Edwards’s missives are always at least a little bit tongue-in-cheek. And let’s not forget that this “new warrior class” is really just the blind leading the blind. Sure, there are undoubtedly some sharks swimming around in there, but crucially, that’s part of the problem.

On Sunday evening, someone finally said what I’ve wanted so badly to say lately. Namely that these trade-themed Reddit boards and finance-focused social media are just modern day boiler rooms.

“Social media is the twenty-first century equivalent of the boiler room brokerage, only the monetization mechanism is different,” JonesTrading’s Mike O’Rourke wrote, in a Sunday evening note. “Instead of boiler room brokers pumping and dumping a stock, social media fuel[s] the passion and the mania with faux expertise,” he added, noting that,

The alarming aspect of recent events is the massive misinformation and the ultra-aggressive social media campaigns used to lure in unsophisticated investors. The talk of this being a “movement” for the common man is only meant to fuel further passion on both sides. Re-posting inaccurate and out of date company share counts and other information is dangerous. A posting of the pertinent data from a corporate press release or an SEC filing is a rarity. The old saying that “if you are not paying for the product, then you are the product” is truer than ever in this market.

O’Rourke’s overarching point seemed to be about the deleterious effects of social media. That’s duly noted (and applies in multiple contexts), but for our purposes here, what I want to emphasize is that for every Seth Davis (Giovanni Ribisi’s character in Boiler Room) on Reddit and Twitter, there are probably 10,000 Harry Reynards.

If you haven’t seen the film, you don’t want to be Harry Reynard. And I see a lot of Harry Reynards in GameStop, AMC, and the like.

The (unfortunate) reality is that the vast majority of people participating in this bonanza don’t understand enough about it (any of it) to anticipate what’s likely around the next turn.

Most obviously, Reddit is just bailing out beleaguered companies and, in turn, bondholders. American Airlines and AMC are selling shares. And they’re not alone. “Pot stock Sundial Growers erased a premarket surge after announcing a $100 million stock sale at a discount to Thursday’s closing price,” Bloomberg wrote Friday, adding that “small-cap pharma stock JanOne raised equity Friday after shares more than doubled over the past two days in a surge that traders linked to retail speculation.”

In all likelihood, other companies that find themselves unwittingly caught up in this mania are going to do the same thing.

I suppose it’s possible to argue that the Reddit crowd is fine with that, but they’re not only bailing out the companies. They’re also helping out the likes of Silver Lake and Oaktree. “AMC should go register more shares, sell as much stock as they possibly can and use the cash to repay debt,” Jason Mudrick implored last week.

Maybe I’m wrong, but I doubt that part of WallStreetBets’ raison d’être involves bolstering distressed debt funds, private equity, and otherwise helping to enrich these companies’ creditors.

But it’s not just the unintended consequences that are problematic for the durability of this would-be “coup.” Markets may not be any semblance of efficient anymore (indeed, market inefficiencies are part and parcel of this whole story), but market makers and the “big game” these retail investors are hunting, aren’t stupid.

“Now that professional investors and companies are on notice, it won’t be quite as easy,” JonesTrading’s O’Rourke went on to say Sunday. “Options market makers will increase volatility quickly in response to future squeeze attempts — as the dislocations start to unwind, the fleeting gains will fade.”

“The smartest, most established hedge funds have likely already dealt with all their GameStop risk,” Kevin Muir remarked. “From what I heard, most of last week was filled with meetings from institutional clients demanding to know their hedge fund managers’ exposure to GME,” he added. “The market has already forced the sophisticated money out of this trade.”

This week’s fascination is silver, which surged right out of the gate following a weekend during which retail sites apparently couldn’t meet demand for bars and coins. This is yet another manifestation of the Reddit pile on.

Whether and to what extent, the “new warrior class” of retail investors will succeed in commandeering this market remains to be seen I suppose. From what I hear, there’s a “strategy.” Demand for coins and bars over the weekend was reportedly comparable to what would normally be seen over three weeks, according to one person who spoke to Bloomberg.

As usual, Rabobank’s Michael Every had an (extremely) colorful take on this latest manifestation of retail run amok. I only wish there were space to recap and discuss it at more length. But, in the interest of brevity, I’ll just excerpt one brief passage. To wit, from a note out Sunday evening called “Long, John: Silver”:

The power to create money, and to demand that money as taxation, IS power (which is also an MMT argument). In that regard one can see why Redditors are lashing out at ‘The System’. Yet if we were to take this power away from central banks and give it to gold or silver –which going long silver will not result in, John — we would simply replace one master with another, and an exogenous one which can’t respond to populism. Yes, such a move would burst our unfair asset bubbles. However, anything so deeply deflationary would likely lead to something far worse than people discussing asset prices on Reddit. There is no Treasure Island waiting – just scurvy, weevils, the lash, and sharks.

It’s just fantastic, isn’t it?

Commenting further in his own missive, O’Rourke said simply, “there will be significant losses on both sides of the equation [and while] institutional investors have taken their lumps first, investors who choose to continue, or to start, participating in the dislocations are placing their capital at serious risk.”

You have been warned.